On Chocolate and Intervention

Monday, June 22nd, 2009 at
5:59 AM

An interesting concept in the world forex markets is that of Currency Intervention. That word has been thrown around a lot during this crisis at various parties…the Japanese, the Swiss, the EU, the Swiss again, more recently. So, what is intervention? More importantly, what are it’s effects?

Intervention occurs when a party with some power (think central banks, govenrments…even individuals) takes some action to influence (increase or decrease) the value particular currency against another. Obviously, there is some perceived value to be gained by the party who engages in this act, even if it doesn’t work out that way eventually.

“Verbal” intervention is a kind of warning shot, or statement of direction. It’s an expression of desire, or a stand on the part of the person or group with the power to influence things. This statement, on it’s own, is able to have significant impact on the value of a currency. Good examples of these might include those statements from Central Bank Officials in certain situations. For instance, in recent months we have seen the Brazilian Real and the South African Rand (amongst others) gain substantially in value against the dollar. While having a decent currency value might be good on some levels, a really strong currency can do a lot of harm, for instance to exports (A stronger currency means other countries have to convert more of their money to buy your products). Such a rise has caused concern. The South Africans haven’t done much, but they have said that some “steps” might have to be taken. While this isn’t the actual policy decision, it does indicate that they are willing to go through with some form of intervention to prevent their currency from continually strengthening. That, in itself, could help slow things down.

The Brazilians have actually been going through with it though. At the end of May 2009, they actively bought dollars against the Real to reduce the value of their currency. Exports again, their reason. In such a situation, it’s understandable. The effect is also limited. No one got their knickers in a twist over that. This was not the case with the Swiss. Switzerland is no stranger to Financial controversy (read the history of the Swiss Banking System). Earlier in 2009 (March, I think) they showed that, when it really comes down to it, it’s every one (or every European) for themselves. How? Well, they suddenly offloaded a bunch off their own currency (Need I say, Exports). This caused it to lose value…violently…against the dollar, but also against the Euro, which is where the trouble came in. Switzerland is part of Europe. This inherently selfish act was bad for it’s neighbors. More consideration was expected from them. But no. The Swiss were looking out for themselves. Talk about Self-Preservation.

Some countries go pretty far down the path of intervention. One of the most controversial…the Chinese. They have an “interesting” approach to this issue. When a consumer buys a product that is manufactured in China, the producers are paid in Dollars. These producers get the Chinese Central Bank to convert their Dollars to Yuan. This is a sale to the Central Bank by the Local Bank where the money is deposited. This process creates an excess of Dollars in the Chineses Central Bank. To balance this, the rules of trade say that the Chinese should sell the Dollars on the Currency Markets and buy the Yuan back. In this way, the Yuan gains it’s value back on the dollar until equilibrium is reached. Ah, if only things were that simple. They are not. The Chinese have no interest in seeing the Yuan gain value. So, they take the path less travelled. They take those dollars and buy US Based assets (All that talk of China owning a good chunk of American…this is where is stems from). The Dollar doesn’t lose value against the Yuan. To make up for this, they print more Yuan. Good times. They do have to worry about inflation though. However, that is something they can live with. It is for this reason that there was a bit of an uproar when Barack Obama’s new team came in. This policy has made it easier for China to weather this crisis. At the G20 meeting, also earlier this year, some people expected that China would get scolded…or at least some remarks about this. It didn’t happen.

The Europeans have been talking intervention in recent weeks as well. All of these strong gains against the dollar are starting to worry everyone just a little bit. It’s just comments from here and there for now. Intervention is not something to be taken likely. However, there is also some talk that the Swiss might be back at it again. That won’t go down well with the rest of Europe. I wonder if any of the European family have decided to boycott Swiss chocolate. Hmmm.

The thing is, intervention doesn’t always work. In fact, more times than not, its effects are only for the short term (let’s not talk about China). It tends to create a quick drop or rise, then the trend continues. This has happened a number of times. Sometimes, this small hiccup is enough for the instigators, I suppose. However, as a long term strategy, it would require more cooperation to succeed properly. The different countries would do better working in tandem. Unfortunately, it’s quite difficult for them to agree on this.